As a smart investor, you want to maximize opportunities to grow your wealth and to take advantage of every financial tool available to make that happen. You also want to give back to your community through charitable giving. So how can you accomplish both?
By opening a donor-advised fund (DAF), you can:
- Give more – Maximize the value of your gifting for your intended recipients
- Pay less – Minimize or eliminate your capital gains taxes on highly appreciated holdings
- Live Better – Make philanthropy a meaningful and lasting family activity
If this little-known option is new to you, you’re not alone. But don’t worry—we will explain the DAF and how you can use it as a part of your long-term financial plan. And you’ll be able to build wealth and give to causes you care about, without sacrificing either pursuit.
What Is a Donor-Advised Fund?
Donor-advised funds are investment accounts that allow you to give to charities you care about. Here’s how donor-advised funds work:
- Donate. You make charitable contributions into your DAF account, beginning with as little as $5,000. You can contribute to your DAF once, or as often as you’d like.
- Receive tax benefit. You receive immediate tax benefits for your donations in the year the giving is done.
- Distribute grants. You can take your time recommending when and to which charities the contributions are ultimately distributed.
- Maintain advisory control. As the name implies, you or an investment manager you name can provide input about where your DAF assets are held and how they are invested.
- Build a legacy. You can bequeath your DAF to a successor as a lasting, family legacy.
Why Invest in a Donor-Advised Fund?
Why not just write checks to your favorite charities and be done with it? When a good solution is also is simple one, that’s exactly what we advise. But there are a number of situations when a DAF makes sense.
For example, through hard work, family inheritance or other unexpected windfalls, you may find yourself in one (or all) of these circumstances:
- Your wealth is tied up in interests that require specialized investment planning and tax planning, such as:
– Highly appreciated, publicly held stocks or mutual funds
– Closely held interests in businesses like C Corporations, S Corporations or LLCs
– Complex life insurance arrangements
– Retirement assets
– Real estate, art collections and similar assets
- You are facing high taxes and tax deductions would be particularly useful
- In preparation for retirement when your income will drop dramatically
- You would like to make a sizable cash gift, but you are not ready to name specific beneficiaries
- You want to offset capital gains when rebalancing your portfolio to ensure that your investment mix is consistent with your goals
In these scenarios (and many others), a DAF can be a great option if you are inclined toward charitable giving.
Think Beyond Cash Donations
Instead of writing checks, look at your portfolio with an eye toward donating long-term appreciated securities (stocks, mutual funds, bonds), real estate, private company stock (S-corp or C-corp) and other potential investments.
Why? Because capital gains taxes are eliminated when you contribute long-term appreciated assets directly to a charity (like a Donor Advised Fund) instead of selling the assets and donating the after-tax proceeds. When you assume 20% for federal long-term capital gains taxes, plus a 3.8% Medicare surtax, contributing to a DAF leads to a potential increase of 23.8% of both your tax deduction and your charitable contribution.
Related video, “A Smarter Way to Give.
How a DAF Works in Your Favor
Our team often holds Cogent Conversations with high-achieving professionals who own thousands of shares of highly appreciated company stock. This is a nice “problem” to have. But it’s still an issue, because it sticks you between a rock and a hard place, when diversifying your personal and professional market risks.
Rock: A great deal of your personal wealth depends on the continued success of your business, and you have no safety net if something horrible derails your company’s growth. Hard spot: Selling shares outright, if even possible, would mean getting slammed with higher taxes.
Enter the DAF as a potential solution. Coordinating tax and wealth managers, we help families explore when and if it makes good financial sense to gift some or all of their appreciated stock into a DAF. From there, you can make grant recommendations on charities you support. The donation makes a huge difference to the charities who receive it, and your personal wealth “eggs” are removed from your risk basket in a highly tax-efficient manner. No more rock or hard place.
Using DAF to Avoid Capital Gains Taxes
Similar logistics apply for any significant collection of highly appreciated securities that would otherwise generate huge taxes when you sell them. If you look ahead several years or possibly to a lifetime of charitable giving, you can pre-fund your giving by using your highest-appreciated securities to establish a DAF today. Then, you get the tax deduction for the charitable gift, avoid paying capital gains taxes when you sell or transfer those securities, and give a sizeable donation for your chosen philanthropic interests.
Multi-year Approach Toward Deductions
Let’s say your income is particularly high this year, perhaps as the result of a year-end bonus, because you’ve sold a business, or you benefited from an inheritance. Charitable contribution deductions may be carried forward for up to five years. You are required to claim the maximum deduction possible in the current year (the deductibility limits are 60% of AGI for cash and 30% for long-term appreciated securities) but you can then carry forward any unused charitable deductions for up to five more years. This is called bunching or bundling. These carried-forward deductions must be used to the fullest amount possible in the next tax year and are considered after any current year charitable contribution deductions. That’s the power of front-loading in a high-income year.
No Benefit for You to Itemize?
The Tax Cuts and Jobs Act of 2017 doubled the standard deduction. As a result, many tax filers may not have enough tax deductions to benefit from itemizing in an individual tax year. However, you can bunch multiple years of deductions into a single year (as described above) in order to surpass the standard deduction. This results in great potential tax savings and maximizes the amount you give to charities.
How to Create a Donor-Advised Fund
There are a number of other scenarios when funding a DAF may make sense for your charitable giving, including:
- Creating a strong vehicle for ongoing giving that avoids the complexities of a private foundation
- Increasing the flexibility of your grant-making timetable
- Building a multi-generational legacy of giving
- Establishing anonymity between your beneficiaries and you
If you decide to open a DAF, make sure your CPA is aware of your intent and involved in the process to ensure you receive accurate and effective tax management for your circumstances.
A DAF doesn’t make sense for all donors under all circumstances. However, if you value giving to charities, and if you want to leave a last legacy, a donor-advised fund can be a potent addition to your financial planning.
How Cogent Strategic Wealth Can Help
Since 2010, we have been helping high-achieving professionals like you support their favorite charities in smarter ways. We can help you explore the different charitable vehicles available and explain how you can complement and maximize your current giving strategy with a donor advised fund. Join us in making your giving simple and more effective.
Contact us today to unleash the power of a DAF in your wealth strategy.
